Constellation Brands, Inc. — Form 10-Q Summary
Business context and period. This report covers the quarter ended August 31, 2011 (the company’s second quarter of fiscal 2012) and the six months then ended. Constellation sells wine and spirits and holds a 50% equity-method investment in Crown Imports, which imports Mexican beer. The January 2011 sale of 80.1% of its Australian and U.K. business (CWAE) makes reported year-over-year consolidated sales comparisons substantially affected by divestiture.
Key financial results
| Metric | Three months ended Aug. 31 | Six months ended Aug. 31 |
|---|---|---|
| Net sales | 2011: $690.2 million; 2010: $862.8 million; down 20% | 2011: $1,325.5 million; 2010: $1,650.3 million; down 20% |
| Gross profit / margin | $283.0 million / 41.0%; prior year $314.2 million / 36.4% | $534.0 million / 40.3%; prior year $584.2 million / 35.4% |
| Operating income / margin | $145.1 million / 21.0%; prior year $133.2 million / 15.4% | $246.8 million / 18.6%; prior year $229.5 million / 13.9% |
| Equity-method earnings | $64.0 million; prior year $66.4 million | $126.2 million; prior year $120.9 million |
| Interest expense, net | $42.5 million; prior year $50.3 million | $86.8 million; prior year $98.8 million |
| Net income | $162.7 million; prior year $91.3 million | $237.2 million; prior year $140.4 million |
| Diluted EPS, Class A | $0.76; prior year $0.43 | $1.11; prior year $0.65 |
Cash flow and balance sheet. Six-month operating cash flow was $517.4 million, versus $306.1 million a year earlier; capital expenditures were $39.2 million. Investing activities used $73.2 million and financing activities used $444.3 million. Financing included $419.9 million of long-term debt principal payments and $187.5 million of share repurchases, partly offset by $113.3 million of net notes payable proceeds. Cash was $10.0 million at August 31, 2011.
Total debt was $2,946.4 million, down $289.9 million from February 28, 2011. Current bank notes were $198.0 million, current maturities of long-term debt $13.7 million, and long-term debt $2,734.7 million. The company had $447.4 million of revolver availability at August 31 and reported $631.9 million available at September 30. Management said cash flows and financing activities should provide adequate liquidity for working capital, scheduled debt service, and anticipated capital spending, absent deterioration in market conditions.
Material changes versus the prior comparable period
- Consolidated net sales declined 20% in both the quarter and first half, primarily because CWAE sales were no longer consolidated. CWNA sales increased 5% in the quarter and 6% in the first half; Crown Imports’ reported sales increased 7% and 8%, respectively, but are eliminated in consolidation.
- Gross and operating margins improved, and operating income increased 9% for the quarter and 8% for the first half. The company attributed the improvement in part to lower restructuring and unusual charges and lower corporate expenses. CWNA operating income declined 8% for the quarter and 3% for the first half.
- Net income rose 78% for the quarter and 69% for the first half. Lower interest expense and substantially lower effective tax rates contributed: the tax rate was 2.3% versus 38.8% for the quarter and 17.1% versus 44.2% for the first half. The 2011 rates benefited from reductions in uncertain tax positions following tax examinations; the prior-year six-month rate included a $30.1 million U.K. deferred-tax valuation allowance.
- Crown Imports’ first-half equity earnings increased, but second-quarter equity earnings declined 4%. Its sales grew on volume, while planned advertising increased selling expenses.
Outlook, commentary, risks, and unusual items
- Near-term outlook: Management anticipated lower U.S. sales and operating income in fiscal Q3 as shipment timing shifts following distributor-network changes; shipments are expected to track retailer sell-through, with some holiday-related shipments shifting to Q4. Management also expected Crown Imports’ Q3 sales and operating income to be lower than the prior-year quarter, reflecting prior-year inventory normalization and increased fiscal 2012 advertising.
- Strategy and market conditions: Management reiterated its focus on premium brands, margin expansion, cash flow growth, debt reduction, and EPS growth. It expected the 2011 U.S. grape harvest to be smaller than the 2010 harvest, but overall U.S. wine supply to remain generally balanced with demand. Actual harvest, supply, consumer demand, and shipment timing may differ.
- Restructuring: A fiscal 2012 initiative targets a 2%–3% reduction in the global workforce following the CWAE divestiture. The company expected related costs and cash outlays to be completed by February 28, 2013. It forecast fiscal 2012 restructuring charges of $11.8 million and other costs of $11.4 million, in addition to $0.3 million of accelerated depreciation.
- Capital allocation: The board authorized up to $500 million of repurchases, with no stated expiry and an expected multi-year implementation. By August 31, 9.77 million shares had been repurchased for $187.5 million; by October 11, cumulative repurchases were 14.52 million shares for $273.2 million. Repurchases were funded with operating cash and revolver borrowings.
- Subsequent event: On October 5, 2011, the company acquired the remaining 50.1% interest in Ruffino for €50.3 million ($68.6 million), settling related legal actions. It also assumed €54.7 million ($73.0 million) of net debt; the purchase was funded with revolver borrowings.
- Contingencies and market risks: CWAE-related indemnifications had a recorded liability of $25.4 million. Potential payments could reach $330.9 million, of which $282.1 million was subject to third-party recourse; management considered material payment unlikely. The company uses derivatives to hedge foreign-exchange and interest-rate exposure, not for trading. At August 31, $500 million of floating-rate debt was hedged at a 2.9% average LIBOR rate, excluding borrowing margins, through September 2016.
- Unusual items: The divestiture generated cumulative net gains of $83.8 million, mostly recognized in fiscal 2011; the first half of fiscal 2012 included only a small net gain, while the quarter included a net loss. First-half restructuring and unusual items totaled $17.3 million, compared with $24.2 million a year earlier. The interim statements were unaudited; the filing cautions that interim results are not necessarily indicative of full-year results.
Important facts for investors to verify
- How much of reported earnings growth reflects recurring operations versus lower tax expense, reduced restructuring charges, divestiture accounting, and other unusual items.
- Whether CWNA volume, product mix, costs, and distributor shipments support the expected recovery in shipment timing, and whether Crown Imports’ volume offsets planned advertising costs.
- Debt repayment capacity and liquidity after repurchases and the Ruffino acquisition, including upcoming term-loan maturities and revolver usage.
- The final purchase accounting, assumed debt, and operating contribution from Ruffino, as well as the settlement of the related legal actions.
- Actual restructuring costs and workforce reductions, the status of CWAE indemnification exposures, and developments in wine supply, foreign-exchange, and interest-rate risks.